COLUMN-Do you need a do-over on your Roth conversion?

Reuters Staff

4 Min Read

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Gail MarksJarvis

CHICAGO, March 7 (Reuters) - If you turned a traditional IRA into a Roth IRA in 2017, you may be kicking yourself now: What seemed like a clever strategy a few months ago may not seem so smart if your account value dropped.

People do this kind of conversion so they can escape paying taxes on investment growth down the road, because Roth accounts grow tax-free. According to the latest IRS data available, taxpayers in 2015 converted about $4.3 billion into Roths from IRAs.

When you move the money, you have to pay income tax on the amount based on the value of the stocks on the day you do the conversion. That is because IRA contributions go in before taxes, and you pay income tax as you take the money out in retirement.

If you did a conversion in 2017 while stocks were soaring, you might want to check in. Since the beginning of this year, stocks have been on a wild ride. While the Standard & Poor’s 500 has recovered from losses and was up 2 percent for the year through Tuesday, your individual holdings may still have dropped.

Some individual stocks are down more than 10 percent. At the end of February, for instance, General Electric Co was down 16.2 percent, and United Parcel Service Inc 10.5 percent. The average core bond fund tracked by Lipper was down 1.6 percent.

So as you do your 2017 tax return you could face an aggravating realization: You owe taxes on sums that have evaporated.

If you converted $100,000 in 2017 and the value in your Roth is now $90,000, then you would still owe taxes on $100,000 in income – which could run more than $20,000 depending on your tax bracket.

The way out? “Try a do-over,” said Ed Slott, chief executive of Ed Slott & Company and founder of IRAHelp.com.

For conversions made in 2017, you can simply send your Roth IRA funds back to your IRA. It is called a “recharacterization,” and with extensions, you have until October 15, 2018, to make it happen.

Despite the changes Congress made to get rid of recharacterizations starting on Jan. 1, 2018, the new tax laws do not affect 2017 conversions.

Going forward, Slott suggests still looking for opportunities to turn traditional IRAs into Roth IRAs – you can do this even if you take a do-over on your 2017 conversion.

Slott notes that doing a conversion will be cheaper for most people in 2018 because they will be in lower tax brackets.

“This is the time to get money into a Roth because taxes are likely to go up in the future,” Slott said.

Yet, without the right to change your mind in the future, he suggests moving slowly on new conversions – possibly waiting until later in the year when you know more about your possible investment declines, your annual income and your overall tax situation.

To limit the impact on current taxes, Phoenix financial planner Alexander Koury is helping a 50-year-old client convert an IRA into a Roth IRA slowly. With a $2 million IRA, Koury is having a couple convert $250,000 each year for the next four years into a Roth so only $1 million remains in the husband’s traditional IRA.

Each year, they will owe about $50,000 more in taxes based on the extra income, said Koury. But the $1 million Roth could grow tax-free to about $2.6 million, based on a modest 5 percent return by the time he retires in 20 years.

That is a huge benefit that does not happen in traditional IRAs. With a traditional IRA, everything withdrawn to cover retirement spending will get taxed each year, and at age 70-½ Uncle Sam forces people to withdraw money every year so the government can collect taxes.

Koury’s conclusion: “Why not pay taxes now and not ever have to worry about paying taxes again?” (Editing by Beth Pinsker and Jonathan Oatis)